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Netflix Inc's Next Step to Become HBO

Netflix is starting to produce more shows in-house.

In its quest to become HBO before HBO becomes it, Netflix(NASDAQ:NFLX) is about to take one of the last major steps necessary to accomplish its goal. The company already plans to become a global powerhouse by expanding to 200 countries by 2017, putting it on par with HBO's global distribution and its approximate 90 million global subscribers.

But securing content rights for all of those countries is no easy feat. That's why Netflix's next step is so important. Bloomberg Business reports that Netflix will opt to produce some of its new shows in-house, just like the Time Warner(NYSE: TWX) subsidiary.

Wait, doesn't Netflix already produce its own shows?While Netflix has a growing catalog of "original productions," the streaming network doesn't actually produce those shows. Instead, it licenses shows like House of Cards and Unbreakable Kimmy Schmidt from outside production studios like Media Rights Capital and Universal Television. It receives the first window rights and exclusive streaming rights for a set period of time, and then the production studio is free to offer home video copies, and even shop around to other networks when the initial streaming exclusivity expires.

This is how most other networks operate, as well, especially cable networks that don't own their own production studios. HBO, however, is one of the few exceptions, in that it produces almost all of its shows in-house. That allows it to control distribution and syndication.

For example, it can hold back the home video release of a series to encourage more people to subscribe to HBO in order to catch up. Moreover, it allowed HBO to launch its stand-alone streaming service, HBO Now, without any negotiations for content rights.

Netflix is looking for the same kind of control, but it also may be the only way it can produce some of its shows. Bloomberg reports that the first major show to receive the in-house treatment from Netflix will be the upcoming Chelsea Handler talk show. It's the kind of show that doesn't lend itself to selling via home video, so production studios are less likely to offer similar value to Netflix compared to other series, because they can't make up revenue on the back end.

But Netflix also says it has plans to produce a pair of comedy series, and the Wet Hot American Summer prequel was produced in-house, as well. Producing more content in-house may make it difficult for Netflix to acquire the rights to other productions, with studios seeing Netflix as more of a competitor than a customer. Netflix says it still plans to work with larger studios for its bigger productions like Orange Is the New Black.

Not just controlling content, controlling costsBringing series production in-house will initially cost Netflix more than simply licensing the shows. For that added cost, Netflix gains more control over that content, and that control extends indefinitely. That also means Netflix is taking on more risk if it produces a flop.

But the risk is worth it because, as Netflix grows more popular, it's cutting into the viewing time of traditional linear television. Cable ratings are declining as total time spent viewing Netflix climbs. As broadcasters see lower returns on their first-run broadcasts through lower ad sales and subscriber revenue, they're bound to turn to the streaming services that are impacting their viewership, and ask for more money to license shows.

Presently, the backbone of Netflix's catalog is its licensed shows, with its original productions providing further differentiation from the competition. As Netflix adds more originals, its goal is for those series to provide the backbone for its catalog, with its licensed shows providing something else to watch, as viewers wait for the next release.

That flip of the script provides Netflix with significantly more leverage over broadcasters and production studios, because their content will become secondary to Netflix's originals in selling subscriptions. What's more, broadcasters can't afford not to license their shows to someone, and Netflix still has some of the deepest pockets.

Gaining more control over its originals will enable Netflix to negotiate better with broadcasters, and keep its costs under control as it expands globally.

Author

Adam has been writing for The Motley Fool since 2012 covering consumer goods and technology companies. He consumes copious cups of coffee, and he loves alliteration. He spends about as much time thinking about Facebook and Twitter's businesses as he does using their products. For some lighthearted stock commentary and occasional St. Louis Cardinals mania ... Follow @admlvy